Category Archives for "Business Income Taxes"

Income from unincorporated businesses is taxed in the hands of the owners. If you earn income from such a business, you must prepare an income statement each year, showing all the income and expenses of the business. The resulting net profit or loss is then transferred to your tax return and is taxed, along with all your income from other sources. The Canada Revenue Agency (CRA) provides standard business statement forms which it encourages you to use in calculating your profit and loss. However, you are not required to use these forms, as the CRA will accept other types of financial statements.

As a small business owner, you are entitled to deduct the ongoing costs of doing business, so long as the expenses are reasonable and have a profit-producing motive. It is important to have a good record-keeping system, however; otherwise it is inevitable that you will forget about certain expenses that you incurred when tax time comes around! Every dollar of expense that you overlook is one more dollar added to your taxable income, so don’t trust your memory. Instead, write it down, and save those receipts! Some of the more common deductible expenses include advertising, promotion, rent, salaries, legal and accounting fees, and auto expenses.

Deductions Available to Your Small Business

The cost of advertising is deductible, as is the cost of flyers, brochures and other promotional activities. This includes the cost of entertainment and business lunches, if used to promote your business to existing or prospective clients. However, unlike advertising or promotion, only 50% of the total cost for meals and entertainment is deductible.

Office rent paid to a third party is deductible. However, if you own your business premises, or run your business out of your home, you may not deduct the rental value of these premises. Instead, you may deduct any related expenses, such as mortgage interest, property taxes and insurance. These expenses must be prorated if part of the building is used for personal purposes.

Salaries and wages paid to employees are deductible in full, as are the employer-paid premiums for Canada or Québec Pension Plan contributions, Employment Insurance, Workers’ Compensation, and sickness, accident, disability or income insurance plans. Salaries and wages paid to your spouse or child are deductible if the work done is necessary for earning business income, and the amount paid is reasonable, or equivalent to what you would have paid an unrelated person for the same type of work. Salaries drawn by you, the owner, are not deductible, however, and should not be included on the income statement.

Fees for outside professional advice or services are deductible, including consulting fees, bookkeeping and accounting fees, and tax return preparation fees.

Legal fees and similar professional fees incurred for earning business income are deductible. These include fees paid for legal advice related to on-going business activities, or to a collection agency for the collection of bad debts. However, legal fees incurred to buy capital property are not deductible. Instead, these are added to the capital cost of the property.

Business taxes and annual business licenses are deductible. Fines and penalties for infractions of public laws, however, are generally not deductible.

Automobile expenses related to earning business income are deductible. If the auto is used only partly for business, the expenses must be prorated between business and personal use based on the relative number of kilometres driven. Apart from proration, there are no restrictions on operating expenses, such as gas, oil, repairs, insurance and maintenance. However, items related to the capital cost of the auto, like capital cost allowance, interest on auto loans, or lease payments, are restricted. For automobiles acquired 2001 and later, deductibility of interest payments is limited to $300 per month and lease payments to $800 per month, plus GST and PST, or HST. Capital cost allowance is calculated on a maximum value of $30,000, plus GST and PST, or HST. Special-use vehicles, such as taxis, hearses, vans, pick-up trucks, or other vehicles used mainly to transport goods or passengers during business are not subject to these capital-cost restrictions.

You may not deduct the cost of capital expenditures (expenses relating to the acquisition or improvement of a property used by the business) in the year acquired. Such expenditures normally supply a long-lasting benefit; therefore, tax law requires that their entire costs be claimed slowly, over a period of years. This is accomplished through the mechanism of the capital cost allowance system, which allows a certain percentage of the cost to be claimed each year, on a declining balance basis. The percentage varies with the type of property purchased. Capital cost allowance rules can be quite complex, since they deal with acquisition of new property, the sale of old property, and a variety of other contingencies.

Fiscal Year

Income and expenses from a business are calculated on a fiscal-year basis, which need not coincide with the calendar year. However, it is no longer possible to defer taxes on business income (except in the startup year) by choosing an off-calendar fiscal year. This is because a formula must be applied to estimate the income earned from the end of the fiscal year to the end of the calendar year, and this amount must be added to income and taxed in the current year. The following year, the extra income is subtracted from the actual fiscal period income, and a new amount for the stub period is calculated and included in income. The elimination of income deferral means that, unless you have compelling business reasons for doing so, it is usually no longer worth the bother to have an off-calendar fiscal year.

Back up your claims for business losses with a sound business plan

Sharing is one of the first things we are taught as youngsters. The same can also apply to the Canada Customs and Revenue Agency (CRA). When your business enjoys a profit, you must share part of it with the CRA in the form of income tax. By the same token, when your business shows a loss, the CRA shares in that loss, since you are ordinarily allowed to deduct the loss against other income, thus lowering the taxes you would otherwise pay.

But first you must meet the “reasonable expectation of profit” test. The CRA is only willing to share your losses if there is a reasonable expectation that there will be future profits to share as well. If not, your losses will be disallowed as simple personal losses.

This means that you cannot deduct losses arising from hobbies or similar activities if you do not ultimately expect them to be profitable. It also means that you cannot deduct losses if the size or scope of your business is such that your expectation of profit is simply not reasonable.

Because businesses are rarely profitable immediately, start-up losses are usually routinely allowed. However, if your business does not show a profit in a reasonable length of time, those losses may eventually be disallowed. Remember that the CRA can go back as far as three years (sometimes six years if a loss carryback claim has previously been filed) to disallow any losses previously claimed. If your losses were significant, the back taxes and interest can be substantial.

Since you cannot always know in advance whether your business will succeed or not, it is important to protect yourself in case you are not able to get your business “into the black” within a reasonable time. You can avoid having your bona-fide business losses disallowed by taking certain precautions, the most valuable of which is the five-year business plan. So, take the time, put in some effort and be fair to yourself!

For example, let’s say you love photography and have spent a lot of money on equipment. Your work is very good and occasionally you have sold some pictures. It occurs to you that, with a little effort, you could turn your hobby into a business. After all, it would be nice to write off all that equipment, wouldn’t it? Before you jump in, however, take some time to do your homework.

First, prepare a five-year business plan, showing projected income and expenses over that period. Estimate how much revenue you can realistically bring in each year. Then list all the expenses required to generate that income. Be sure to include all expenses that are deductible for tax purposes, including the cost of any personal items you intend to use in the business (for capital items, include depreciation only). Your business plan should also indicate who your intended customers are and how you intend to reach them. It should explain how and where you will obtain the necessary financing, what management skills and expertise you will contribute to the business, and what you must hire from others.

Now study your business plan. Do you have what it takes to run a small business? What are the projected profit/loss figures for the first five years? If your business plan indicates serious deficiencies, or projects persistent losses, you should either revamp your plan, or else continue your photography simply as a hobby, not a business. In other words, until you have a workable business plan, you should consider the losses to be the personal cost associated with a hobby and forget about trying to write them off on your tax return.

However, if your plan is sound, and the projected profit/loss statement shows an upward trend resulting in profitability after a reasonable length of time, you probably have a viable business, even if there are losses in the first few years. If you decide to proceed, use the business plan as your blueprint for building your business. Remember to save one copy of it for your files: it may come in handy if the CRA decides to look more closely at your business sometime down the road.

At the end of each year, compare your actual income and expenses to the projections in your business plan. If your losses were larger than you had projected, figure out why. Were your expenses higher because your business plan overlooked some regular, recurring expenses, or were there start-up costs you didn’t account for? Was your revenue lower than expected because you over-estimated the market or didn’t advertise enough? It is important to determine the cause of the discrepancy, and whether it is a one-time thing, or an on-going problem. Then make the necessary corrections and revise your business plan accordingly.

An Example

To illustrate the importance of the business plan, let’s assume you started your photography business without one. Let’s further assume that things did not go well at first, and you showed consistent losses of $3,000 in each of the first three years. You still think that it is a good business which will eventually make money, but the CRA, looking at your track record, decides to disallow your losses for all three years – all on the basis that you had no “reasonable expectation of profit.” Without a business plan, it is difficult to challenge that judgement. Thus, you could end up out of pocket, not just for the original $9,000 loss, but for the back taxes and interest on that amount of money as well!

How would a business plan help you? First, it would give you an objective, concrete basis for judging whether your business is likely to make a profit. After all, maybe the CRA is right; maybe you were just engaged in “wishful thinking.” A business plan would have indicated this to you much sooner and allowed you to cut your losses before they became too large.

On the other hand, maybe the CRA is wrong. Maybe your expectation of profit is entirely realistic. Maybe the losses were due to unusual circumstances, which have since been rectified, or were a necessary part of getting started in a cut-throat business. A sound business plan, adjusted yearly, will help you prove your case. It will enable you to counter the CRA’s perfect “hindsight” with facts and figures instead of unsubstantiated hopes and dreams.

Thus, instead of paying taxes on disallowed losses, you could invest that money in the business. Or better yet, spend it on something fun, like a well-earned vacation.

Often times during a small business start-up, the last thing thought about or taken care of is dealing with taxes. This is a huge mistake that must be avoided at all costs. Thinking about the various types of taxes that have to be dealt with when starting a new business should be a priority. In order to keep Canada Revenue Agency (CRA) and other taxing agencies happy proper record keeping is a must. Proper planning in the beginning stages of a new business will make doing taxes much easier when the time comes.

Here are a few simple tips to assist in keeping proper and adequate records.

Any time a purchase is made, it is critical that the receipt is kept and filed in a safe place like a locking file cabinet or at a minimum a file box. If ever audited by CRA, it is essential that all receipts are made available, as they will most certainly request receipts to verify specific purchases. Proof of expenses must be provided to CRA or they will disallow them as an expense and add that amount back into the income category.

Another area that tends to suffer in the small business community, is not keeping business financial books current. Falling behind with bookkeeping is not only frustrating but takes much more time to sort out when trying to catch up. To remedy this, write down all income and expenses as they happen, preferably on at least a daily basis. Organization is an integral part of successful business ownership, and organized books are not only essential in keeping CRA happy, but in helping track the performance of a business.

More and more the government, including CRA, is accepting electronic records. Let’s face it, most receipts are printed on thermal paper now, which degrades over time or even be destroyed. Scanning your receipts and keeping the original with the scan is a great way to ensure you always have your records.

Regardless of the type of tax that may need to be paid (income tax, payroll tax, state tax, etc.), it is critical that the filing of the proper forms is done on a timely basis. Late filing and late payment of taxes will result in paying hefty penalties and interest on the balance owed to the various taxing agencies.

Audits by CRA or other taxing agencies do not have to be feared, as long as the proper documentation is in order. Again, the more organized the records are, the easier it will be to prove and make a case to improve the businesses position. Statistically small businesses and small business owners are audited more often by CRA.

In closing, any existing small business or brand new start-up can see that proper record keeping should be a priority. The hiring of a professional bookkeeper and/or accountant to assist in setting up and maintaining the books is a highly beneficial option that should be seriously considered.

Many small businesses, especially single proprietorships, have scaled-down accounting operations. If you’re one of those small business owners who work on simplified accounting, you should still make it a point to work on your taxes before the year ends. While everybody files income taxes in April, do remember that those taxes are for the income earned during the prior year. Hence, you should take advantage of the time until the end of the year to work on your income and expense accounts so you could cut down your business taxes come April. This should also provide you with the opportunity to plan your financial strategies for the next year.

Great Tax Tips for the Small Business Owners

While you may be excited about the upcoming holiday celebrations, do remember that you still have a few things to do for your business. Take a look at the following year-end tax tips:

Review the financial standing of your business.

There is no problem if you are handling the financial aspects of your business by yourself; many other small scale business owners do because they cannot afford an accountant’s salary. Just remember to take a close eye at your year-end profits because that will be the basis for your taxes. If you wish to pay lower taxes, then you have to show a smaller profit. You can do this by drawing as much as you can as your December paycheck. And before the year ends, make sure that you reduce the total amount you are depositing to your business account. Then, try to issue as many checks as you can to pay for all your business-related expenses.

See to it that all bills due in December are paid early.

Go over our bills one by one, and pay them all – rent, utilities, insurance, health care, as well as the Christmas bonuses you promised your employees. You should be able to increase your deductions and end up with lower taxes.

Now is the time to buy your office supplies and equipment.

One smart move is to replenish and perhaps even add to your office supplies before the year ends. Remember, your strategy to decrease taxes is by building up your expenses. The purchase of office supplies should do the trick for you. If you had earlier planned on buying some expensive office equipment like a new computer system, or renovating your office and buying new desks and chairs, you may want to execute your plans before the new year rolls in. However, make sure that your planned expenditures can be supported by your current cash flow. Moreover, everything that you purchase should be delivered, installed and in use before the end of the year.

Income deferment

If you are using the cash-based accounting method, you can delay the invoicing to your customers and collections from your sales until January of next year. This will effectively reduce the revenues booked for the current year that are taxable this coming April.

Some More Year-End Tax Tips

And if you don’t have one yet, you may want to arrange for your individual retirement plan. Not only will this help you prepare for your future, it can also provide you with tax shelter benefits. Still, you should realize that if you are running a home-based business, you are entitled to deduct portions of your home expenditures from your business taxes. Authorized deductibles include a share of the rent or mortgage payment, utilities, and other home maintenance expenses.

These year-end tax tips should be able to help you prepare for the unavoidable tax season. With that out of the way, you can truly enjoy the holidays with friends and families.

As a business owner, there are certain records that you need to keep. The obvious being your receipts for expenses you incur and your invoices for your sales. There are other records that you may not realize that you have to keep, such as employee information and payroll documents, contracts, leases, and more.

Income and Expenses

You must keep all your invoices you’ve sent to clients, and even those that you voided. It is best if your invoices are consecutively numbered (1,2,3, etc.). You can keep these electronically or through your accounting software. If you’re going to keep a paper file, sort them by invoice number, and make sure there are no gaps between numbers.

For expenses, keep all receipts for your debit, credit card, cheque, and cash purchases. That means keeping all your telephone bills, cell bills, vendor purchases, meals, advertising, etc. Make sure that for every entry into your accounting system, or showing up on your tax return, there is a matching receipt. Most audits crash and burn because the receipts are not there. You can keep receipts in what CRA calls ‘electronic imaging format’, which basically means a scanned document.

Government Remittances

You must keep all of your government remittance forms you’ve filed including: payroll remittances, GST/HST returns, provincial sales tax returns, workers’ compensation, and any other government agency remittances you need to make. Plus you must keep all documents that support your remittance and any calculations you did to come up with your remittance amount.

Format

You keep records in the format in which you received them whether paper or electronic, plus scanned documents (though at the moment it’s best to keep the paper copies). If you’re using accounting software you must keep a backup for each fiscal year in a safe and secure location (safety deposit box or online is best). For online accounting software, you should do a backup, usually to a spreadsheet, each fiscal year or a printout (paper or PDF). If you’re using a spreadsheet, you should have one for each year and also kept safe and secure. If you’re using a manual system, then we need to talk.

You must also keep all records in Canada unless granted permission to do otherwise by CRA. And, you must make all records available to CRA upon request. Note that CRA can take a backup of your accounting software and run it through their system; from my understanding of the system they use this to flag items they want to look at.

Other Documents

There is other documents that you need to keep that relate to your business and most will relate to your expenses you’ve incurred, some can relate to your sales too.

Payroll documents are the first thing that comes to mind. You must keep employee information (SIN, address, wage rate, etc.), TD1s filled out, employment agreements, ROEs, and paystubs (these will show the hours worked and deductions taken). The best way to keep this information is in a folder per employee; can also be electronic.

Contracts for leased equipment, vehicles, property (your office outside the home), and service contracts for consulting, marketing, etc. Make sure you keep copies, as most of these contracts will state the total value of the contract, the monthly payments, and the sales taxes.

If you have sales agreements, or other agreements/contracts, with your clients, make sure you keep copies, especially for those sales that are a monthly recurring amount.

As you can see, there are many records that you have to keep, for that just in case time that CRA, or some other government agency, comes calling and wants to check over your records.